When central banks fail to do their jobs properly

We have just experienced the bargain purchase of one of the 300 banks considered as systemic, Credit Suisse, those that you cannot let fail, but this is nothing new. We have known about its problems for a long time and this bank, like others, had lost its only real asset, credibility. A bank mired in all kinds of scandals and financial losses has not been adequately supervised. While it is true that its central bank is not to blame, it is responsible for demanding measures to avoid systemic damage. But CS is one more in a chain that began on the American West Coast and is going to spread across the planet. And it will spread because there are many banks with similar problems to these where the central banks have not demanded the appropriate measures at the time, concentrating on raising rates without analyzing the damage they are causing to other banks and the public in general.

March 20, 2023Reading time: 4,50min

Some years ago, perhaps the best book I have ever read fell, into my hands by chance. Not because of its literature, but because in short stories, most of them without much delicacy in the writing, it tells how executives have been “creative” when it comes to straightening out a business course that was not crooked. The book is entitled “The misfortune 500. Featuring the Business Hall of Shame” -how many of these stories are perfectly extrapolable to what is happening now, but not only with banks, but also with central banks-.

Let’s start with the latter.

Central banks only have one shareholder to serve, the citizen, but since he does not make noise and only shouts when his leg has been amputated, they end up serving the financial markets, because the latter not only complain, but also shout when decisions are not in line with their interests. And although it may not seem so, they have a lot of influence to move chairs.

“Central banks have only one person to serve and that is the citizen. Their mouths are full of their name but with many of their actions they seem to forget it”.

I don’t think anyone at this point doubts my ideology. I am a liberal both economically and in thought and as such I believe that the States should be as small as possible, leaving the decisions on how to spend the money to those who know best how to make them, the citizens. For if they have been smart enough to earn it, they cannot be dumb enough to spend it.

“the attitude of the ECB a few months ago was exemplary, but it has embarked on a race, perhaps to make it look like they are doing something, which is massacring the economy”

But in this scenario regulators play a critical role, and in banking the role is doubly critical.

Banks are the circulatory system of our society and who manages the flow of blood to circulate are the central banks. They must make their decisions to give the best and longest possible life to each of the body’s cells.

Well, they seem to have forgotten. They have embarked on a race to raise interest rates that is destroying our economy, and if not, we will see.

They have taken the manual and like a bad teacher they only apply it. That manual of which we all know the script, but which was written in a different situation and at a different time.

This rate hike is clearly inappropriate in Europe, where our inflation is derived from a “supply shock”, i.e. a critical product of the supply chain is missing, energy, which immediately makes the final product more expensive.

I understand that, since we pay for energy in dollars and the Fed has embarked on its own rate hike path, we should follow it to support our currency, but there is a limit to everything.

The exchange rate with the dollar had become an inflationary factor per se. But if, even thoughenergy stops rising, you do not control inflation, change your strategy because it has been proven not to work.

Many have asked me what to do and clearly the answer is to reduce the money mass in circulation. But drastically, not at the rate they are going, where the impact on inflation is ridiculous, to say the least.

And then came Credit Suisse and Sabadell and Deutsche Bank,…, and what does this have to do with the other? Well, let’s go case by case, but they have one thing in common: the structural damage they suffer is irreparable and to top it off the situation has been consented to by their respective central banks. Then we will go to the Americans because I do not know what is more shameful, what is here or what is there.

“Monetary policy measures are of two types, but it seems that one of these has been forgotten, although they have been used without moderation for 12 years”.

Banks are private entities and should remain so. If we nationalize them, we will turn them into puppets of the politicians of the day, who, and to a greater extent the populists, only know about banks where the ATM is.

But banks are regulated and super-vised entities, i.e. the regulator has the power to “demand” many things to ensure the viability of the bank. Therefore, Credit Suisse or Sabadell should have been forced to be sold, because their survival conditioned the health of the system. Whether the shareholders and/or managers like it or not.

In both cases, neither the buyer wanted to sell, nor the buyer was willing to buy, and both operations were not closed. Along the way, a gust of wind came from the other side of the Atlantic that damaged a very shaken confidence and what happened was what happened.

Credit Suisse has sold for SFR 3 billion, 5 billion less than the closing value of two days earlier and after plummeting. I don’t care about the CS investors, but the damage that the Swiss Bank with its previous permissiveness has caused to the system has no name. Well, Bco. de Sabadell is the same and here the culprit is the ECB.

Many years ago, when I was young, I read the biography of Lee Iacocca. For those who do not know him, he was the president of Ford who relaunched the company when it was sinking and as a reward Henri Ford III, whose surname must have thought it conferred him supernatural knowledge, decided to reward him with the dismissal.

This man, of very humble origins – I still remember his theory of the origin of pizza – went to play golf and to enjoy his wealth, until some smarter than Ford “rescued” him with a titanic mission, to revive the dead man who was already Chrysler.

Iacocca said that, after a very quick and detailed analysis, he published a long and immense list of layoffs, the corollary of which was: “these are all the layoffs and there will be no more”.

You cause the necessary pain and announce the measures to be taken, reassuring the people. Lagarde, believing herself to be Moses (the slang name I give to Mario Draghi) said the other day that she would do whatever was necessary to save the banks and even had creative measures. I don’t know right now if she called us idiots, because we were not able to understand those measures (that’s why she didn’t count them) or she was the idiot because she doesn’t know what to do if this happens. And I don’t know which is worse.

“The bad news quickly and at the beginning and immediately afterwards the solutions to the problems, but it seems that Lagarde does not think like that”

And what they do is to raise rates and announce more hikes next May, causing great damage to domestic and business economies. Come on, the best thing to build confidence.

The other day Joe Biden, following the bailout of Silicon Valley Bank (SVB), came out, as the right-winger he is, giving confidence to those who should have it, the citizens, and he clearly said that depositors should not worry. The Treasury would insure all deposits, but it was not going to bail out a single investor, which was capitalism. He forgot to talk about the noteholders but I imagine that by the tone he used in his conference he included them in the chapter on investors.

Like Iacocca, bad news, fast, at the beginning and making the future clear. The opposite of what Lagarde has done at the ECB. But now it is the turn of the FED and we are going to see who is more like Biden or Lagarde, because the role of the FED until now has been shameful.

For those who do not know it, I will tell you that, unlike the ECB, whose mandate is only to control inflation, the FED has another mandate, which is to collaborate with monetary policy to full employment.

Having achieved this, they go with the donkeys, wearing earmuffs so that nothing can stop them from going off the beaten track. But both banks have sinned of the same thing, a poor and deficient supervision of the banks under their umbrella.

SVB and First Republic Bank are “small” banks, about 70% of the size of Sabadell, and were created a short time ago, especially SVB, with the aim of occupying a very specialized market niche, that of financing start-ups and the purchase of their shares by Venture Capital Funds.

These banks, mostly based on the American West Coast, had assets (financing of the operations) that were illiquid or illiquid in the medium and short term, sweetened with Treasury bonds of a very high average maturity. When the FED began to raise its rates, the SVB, to prevent a flight of its deposits that compensated those assets, had no choice but to first raise rates in line with what the FED was doing and then raise them higher and faster so that people would not withdraw their money, because that would cause its bankruptcy.

So that we understand the magnitude of the problem: it wanted to “auction” but in the end there was only one bidder, assets (those from before) valued at 2.3 billion USD. They received for them, 500 M, i.e. they pocketed a loss of 1,800 M USD and were willing to sell their 2,250 M $ bond portfolio to their advisor -please God keep me away from advisors like that- Goldman Sach, where the squeeze was so strong that it did not even happen. From there, you know the story.

“Unfortunately, there is no hedge at an affordable cost to cover the structural damage to your balance sheet, and that happened to the Americans”

And do you know what their bankers did? Well, they were involved with the “jet set” of the Valley and, among other things, they financed the purchase of wineries, airplanes and mansions. And who says it is a banker who was in the SVB since its foundation, 30 years ago.

In conclusion, this disaster will end up fixing itself, with hardships for the citizens. In the USA, some managers will end up in jail, but the members of the FED, guilty by omission, will remain in their posts. And in Europe no one will go to jail and no one will resign.

Inflation will correct itself by the simplest and most painful method, by “vegetative evolution”, higher interest rates that cause less disposable income, which leads to less spending by citizens and therefore more unemployment. Simple.